UK inflation figures continue to disappoint as the European Central Bank buys more peripheral euro zone debt

After the results of the frankly disappointing Basel 111 banking regulation accord were released late on Sunday evening we saw equity rallies pretty much around the world. The Dow Jones Industrial Average rose by 81 points to 10544 and the UK FTSE 100 rose by 63 points to 5565. For the UK equity market this means that the FTSE 100 has rallied by 9.7% since its recent intra-day low of 5071 on the 25th August. Of course we have a large banking sector and just to give an example of the performance one of them Lloyds Banking Group had a low of 66p on the 25th August and closed at 78p yesterday for a rally of 18% in less than three weeks. Of course a marginal price does not necessarily indicate the ability to sell a large part of a bank but UK taxpayers at least have an asset that is currently valued more highly than before.

Japan’s Prime Minister survives a challenge

One market which did not follow the rallies is Japan as the Nikkei 225 equity index dropped by 22 points to 9299. Part of the reason for this decoupling is that there was a vote on who will be Prime Minister in Japan  today. As to whether equity markets were unsettled by the fact that Naoto Kan kept his position or by the fact that Mr.Ozawa who had been embroiled in a corruption scandal not so long ago felt able to stand at all I am not so sure. One subject which reared its head very quickly after the victory was the strength of the Yen which rose to a fifteen year high at 83.25 versus the US dollar on the announcement. This is partly a function of US dollar weakness as the exchange rate versus the Euro at 107.24 is not quite as strong. Returning to the Nikkei 225 it is now some 1245 points lower than the Dow Jones.

Most countries would be grateful for strength against the US dollar as the fact that many commodities are priced in US dollars means that many import prices which are often input prices as well are reduced by such a move. However for Japan this is something more like a curates egg as she is mired in disinflation which the Bank of Japan is trying to end.

European Central Bank buys more peripheral debt

After all the rumours last week that the Securities Markets Programme was back in action, today we have confirmation that it was. For those unaware of the programme it is the one which the ECB uses to buy peripheral nations debt in the euro zone. Actually this should be against its constitution but a ruse was used to get round this by declaring that the markets were in a type of disequilibrium which the ECB was stepping in to help. After the shock and awe announcement of May 10th the ECB bought some 16.5 billion Euros worth in a week but over time it has scaled down its buying and up until last week seemed to have pretty much stopped at a total of 61 billion Euros.

The European Central Bank bought 237 million Euros of government bonds last week  which is  the biggest amount since the middle of August. Although this is not announced officially these purchases would have been of  Greek, Portuguese and Irish bonds  as the extra premium these so-called peripheral euro zone markets have to pay in interest rates over Germany rose because of deteriorating sentiment. The extra  yield spread over Germany that Portugal and Ireland have had to pay in interest rates for 10-year bonds hit record levels last week and the reasons for this were documented in my articles of the 7th and 8th of September and I first introduced the Securities Markets Programme on the 10th May.

In the short-term the buying appears to have helped calm things down a little as Portuguese,Irish and Greek ten-year government bond yields closed at 5.77%,5.85% and 11.58% last night respectively which are improvements on the recent highs. However the ECB’s figures are only up to last Friday so they may have been buying again. Each of these three countries face serious problems which will mean that the issue is unlikely to go away for long. On this subject the sovereign wealth fund of Norway has rather gratuitously announced it had been buying Greek government bonds. I say gratuitously because it has a lot of money due to Norway’s vast gas and oil reserves and no doubt buys plenty of assets but it does not usually go to the trouble of advertising this. So it looks as though some form of political/official spinning is going on for Greece which does coincide with her politicians going on a roadshow to try to sell her bonds. There is an auction of 6 month Treasury Bills today which if the roadshow is going to have any effect will need to go well so perhaps we should expect that as it would appear that we may well be being primed for this.

Central banks: The Federal Reserve

On the subject of central banks buying sovereign debt we also find that the Federal Reserve in the US is stepping up its purchases of government debt under its QE-lite programme. After buying some 18 billions dollars worth in its first month it plans to buy some 27 billion in its second. This leads me to two think of two themes.

1. What happened to central banks exit strategies?

2.Central banks are becoming entangled in almost every market which cannot be healthy in the long run and may not be in the short run either.

UK Inflation issues continue

Last week saw the publication of producer price figures for the UK. These are useful because they give us an idea of inflationary pressures that are in the  system but have not yet emerged into prices in the shops. According to the Office for National Statistics they were as follows. Output price ‘factory gate’ annual inflation for all manufactured products rose 4.7 per cent in August and input price annual inflation rose 8.1 per cent in August compared to a rise of 10.8 per cent in July.

So whilst the figures have reduced a little from the recent highs we still have a problem particularly with input price inflation which is way above any of our other inflation indices

Consumer Price Index

The figures released this morning show our inflation rate as measured by CPI was unchanged in August at an annual rate of 3.1%. If we look at the month on month move this is somewhat concerning as prices rose by 0.5% which compares with a month on month fall of 0.2% in July. Indeed further scanning of the detail of the statistical bulletin implies that we were close to a rise on an annual basis to 3.2%.

Although the 1-month movement was a 0.1 percentage point higher this year, the CPI 12-month rate in August 2010 remained at 3.1 per cent, the same as in July 2010 (the 0.1 percentage point difference is due to rounding).

What caused this?

There was upward price pressure from clothing and ,food and beverages (particularly wheat and cereal products for those following the developing “agflation” story). This offset overall falls in transport and fuel costs (air transport costs rose but other fell by more) and falls in the furniture,household equipment and maintenance section.

Perhaps the most interesting development has been that recent falls in the price of petrol and diesel were offset by price rises elsewhere. This has been a familiar trend in recent UK inflation experience as invariably any price falls seem to be offset by other categories.

Retail Price Index

Both main measures of the RPI fell from 4.8% to 4.7% and they mirrored each other because there was no particular change in mortgage rates which are excluded in RPIX our old inflatio targetn measure. Air transport and car purchase costs have different weights in the RPI as opposed to the CPI and it is these components and their different treatment which led to the recorded fall in the annual rate of inflation.

Comment and Analysis

These are poor figures for several reasons. Firstly we keep being told by the Monetary Policy Committee that price rises are “temporary” and yet we find inflation is still more than 1% over its official inflation target and more than 2% over its previous inflation target. The level of CPI inflation has been at least 1% over its official target for all of 2010 and the excuses we are given for this which in my view were never very strong (please see my articles on inflation from the beginning of 2010) are even weaker now.

There was some hope that this months figures might be an improvement based essentially on falling fuel prices but as I have pointed out above we seem to always have some inflationary pressure in our system. Indeed so-called core inflation, which excludes the cost of food, tobacco, alcohol and energy prices, accelerated to 2.8% from 2.6 % in July. Many economists use this as a sign of inflation to come and were expecting it to fall not rise. I have written before that there are bigger fans of the concept of core inflation than me as for a start its definition excludes food and energy which strike me as being somewhat vital, but the fact is that it appears to be rising again.

So our inflation problem in the UK is ongoing. This means in my view that the Monetary Policy Committee made a policy mistake,in my view, by not nudging interest rates higher at the turn of the year as I suggested at the time. I notice that one member of the MPC and four members of the so-called shadow MPC wish to raise  interest-rates now. As there is a twelve to eighteen month lag in the main effects of an interest rate rise I fear that even if they should win the argument it will now be too late. This returns me to my earlier theme of central banks having more and more power and intervening ever more. If you look at their record this is a troubling development as they are far from being infallible and may well be a partial architect of our current problems rather than a solution to them.


15 thoughts on “UK inflation figures continue to disappoint as the European Central Bank buys more peripheral euro zone debt

  1. Hi Shaun,

    “If you look at their record this is a troubling development as they are far from being infallible and may well be a partial architect of our current problems rather than a solution to them.”

    I agree entirely, and it is clear that this is due to their composition. Rather than being truly “Independent” those making these decisions seem to be originally chosen nowadays for their semi-neo-Keynesian and left-leaning persuasions, rather than on any basis of true neutrality. It is thus hardly surprising if they then put these persuasions into action rather than adopting any neutral stance?

    In my opinion this is because Western governments know that unless they select such people to pose as “Independent” they will not have carte blanche to continue their now well-established gambit of partial deficit financing with fiat currencies using inflation.

    • Hi Drf
      Central banks are definitely overstretched at this time both in terms of the roles they are trying to fulfil and I think in terms of the quality and knowledge of the people on them.

      As to today I hear that UBS,who should be well informed, think that the Swiss National Bank may raise interest rates on Thursday. When I asked central bankers to come up with more novel ideas that wasn’t quite what I had in mind….(for those reading this who may be unaware of the situation the Swiss Franc has been a very strong currency this year and the SNB spent a lot of money intervening to try to stop it rising).

      • Hi Shaun,

        The idea of the Swiss raising their base interest rate when their currency is already so strong is a mind boggling concept! One waits with baited breath to see what will happen?

  2. CPIY , exactly the same components as CPI but excluding indirect taxation was unchanged in August at 1.4%.
    So the BoE should increase rates to do what exactly? Give a warning to the Government that it is increasing taxes too much?
    This isn’t Keynes versus Austria, its just common sense.

    • Hi JW
      Thanks for the comment. As to the value of CPIY of 1.4% this adds to one of my themes. I feel that CPI is an inferior alternative to RPI as both an inflation measure and an inflation target and that the replacement of the latter by the former was a policy mistake. This is inspite of the fact that RPI has its own weaknesses, it simply has less of them.
      Anyway if we look at RPIY it is at 3.4% which means that using our old inflation target would leave us with above target inflation even allowing for indirect taxes such as VAT.

      The best indicator of all is the implied deflator as it can cover the whole economy and as I wrote yesterday.
      “I reported at the time of the figures that the GDP implied deflator had risen to 4.1% and that this is an indicator which is superior to all consumer or retail price indices because it covers the whole economy rather than a sub-section. As it covers the whole economy one can use it to look at inflation taking out the impact of the indirect tax (VAT) rises, and if you do so you end up with inflation estimated at 3.2% annualised over the past six months. Actually to exclude indirect tax rises you end up excluding import price rises too and as they look like they have been positive then the picture is if anything worse than that.”
      I think that it gets mentioned rarely for two reasons. One is that it is based on quarterly GDP figures and so does not give us a monthly headline and the other is that it is not as well known or publicised as CPI or RPI.

      • Arguing about whether RPI or CPI is best is surely a waste of time. Like all statistics, its probable we could drive a coach and horses through the ‘holes’ in the data, assumptions etc in both.
        There is of course an additional difference between RPIY and CPIY, mortgage interest payments.
        GDP deflator will have all these problems and more. Just look at how GDP is adjusted post-event, the same must apply to the deflator statistic which is a derivative of an ever-changing feast.
        My point was that a sizeable component of any of these stats is the governments own rapacious appetite. Not just VAT but all those lovely ‘green’ taxes its levying in increasing numbers.
        With velocity of money and wage increases both dormant, with the major contributor to price increases being the government itself, and commercial interest rates including hefty margins , I can’t see a logical justification for increases in base rate.
        Its clear what the MPC are doing, but without running a serious risk of society breakdown , I don’t see an alternative. We shouldn’t be where we are, but we are.

      • JW,

        It sounds to me as if you may have a fairly substantial mortgage? I get the impression that your motivation is perhaps a bit personal and short term rather than what we might loosely term Nationalistic?

  3. I am puzzled in the extreme that low interest rates were said to have caused all this trouble and yet the cure being touted is – low interest rates. Is there really a sign of a cure?
    I have questions that some of your erudite correspondents may answer for me: How many people in the UK live on a top up of fixed interest investments, and how much of their spending has been curtailed by low interest rates, and what proportion is this of normal wage generated spending?

  4. @robert Mcgrath – I cant answer your question directly (and I am certainly not erudite!) but I think it more pertinent to ask “How many people in the UK live on a top up of fixed interest DEBTS, and how much of their spending has been INCREASED by low interest rates, and what proportion is this of normal wage generated spending?”

    My man-of-the-people on the back-of-an-envelope, finger-in-the-air, anecdote-on-a-blog calculations tell me its quite high, particularily those who are highly ‘invested’ in stock markets and property – the middle classes.

    Those who borrowed to speculate on rising prices are now stuck. They cant sell as they are not in profit enough to maintain a certain lifestyle; indeed many are nursing serious losses.
    The low interest rates allow them to hang on to dud investments until things ‘get better’.
    Its not quite debt forgiveness but it is certainly debt mitigation – leaving lumps of capital malinvested, losses unrealised and gumming up the system for those who could put this capital (or assets) to better use.

  5. Thank you for the reply, and I do agree with you, but I was interested if figures could be placed on how much spending was curtailed by retired people when their self-subsidizing was forced to stop. This could be a very important figure when considering the effect of lowering the interest rates. And also if the problem was created by too much debt then the people in this debt are not really likely to borrow again no matter how cheap the money is made. That was how I was thinking, but your explanation of attempts to keep the status quo at least gives a logic to having low interest rates.

  6. Your “my man of the people” idea set me thinking maybe I could put a conservative estimate to my problem.
    Assume 15 million pensioners. 10 million have occupational pensions, 5 million have savings of guess 25 thousand which at 5 % gave them a 25 pounds top up on their 100 state pension. Withdraw that and give it to the banks it amounts to 7.2 billion / year. This I reckon is a very conservative guesstimate. It would, however be easy to accurately discover by merely sending out a form to several thousand pensioners in a prepaid envelope and ask them! Is the amount I have put forward worth considering in the macroscale?

  7. Response to Drf ( no reply button against his comment).
    I am pointing out that the ‘Price statistics’ included a large component of indirect taxation increases. I am questioning whether a base rate increase would be applicable in this situation, given the moribund state of maney velocity and wage increases.
    How exactly do you arrive at the conclusion this has anything to do with my personal finances? Or are arguments against a ‘hair-shirt’ monetary policy threatening to you in some way?
    We seem to be at the start of a real reduction in wealth for most western societies probably of the order of 20-30%. I don’t see how making the pain of that even more extreme is in anyone’s interest.

  8. I actually didn’t need to do a thumb suck because the ONS (office of national statistics) has it all there. To me it is a staggering sum of 50 billion a year that is generated from investments to make up their income. I assume that the large part of these investments are bank deposits. So I ask again: does lowering interest rates to benefit the users of capital really do so much for the economy? Do the overborrowed continue borrowing? Whilst fixed income users have to stop spending?

    • Hi Robert
      I am building some thoughts along these lines for an article or two. In essence I feel that there may be unexpected consequences from taking interest rates to or near zero. Keynes called it a liquidity trap but I wonder if the old assumed relationships between the marginal propensity to consume of savers and debtors does not hold as well down here. If not it would explain some current difficulties. Also the speed and size of the move may well be factors working against normal relationships. Just to add to the mix my old tutor at the LSE is no advocating replacing ZIRP or zero interest rates with negative ones(NIRP?) which to my mind is more likely to make things worse than better…

  9. I think the models used by the ‘experts’ at the BOe and the Treasury are out of date. Recessions in the past of course provide an insight in to behaviuor in the the next, but not if the fundamental structure is different. Firstly the economy is much more gloabbly integrated now. So lower interest rates produces lower sterling which benefits manufacturing goes the theory. but, not if the manufacuring is largely done offshore and is rpcied in Dollars. It jus increases inflation. We have now seen that in action, and it did not happne the same way in the 90’s. I also agree the the second problme with the model is that it underestimates the value of savings. As property prices grew, so too did inheritence. Much of that ‘wealth’, is passed on, and I guess that eighteen years on from the last recession, the balance between debtors and savers has changed, and I agree I do not think lower interest rates provide the boost that they used to.
    If the model is wrong, then the decisions are wrong too.

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